Central Banking Is Not Central Planning

A few days ago in my posting on gold and ideology, I remarked that gold ideologists like to accuse central bankers of being central planners. I am not sure when this particular form of rhetorical character assassination got started, but it has become a commonplace of attacks on the Fed coming from the gold party. A Google search on “central banking” together with “central planning” generates 54,600 results. Here are some results from the first page.

Now I am hardly one who thinks that the Fed does not deserve to be criticized for many sins of commission and omission over the years. On the contrary, I believe that it bears a heavy responsibility for the Little Depression in which we have been mired for over three years. But, whatever its faults and mistakes, that hardly makes the Fed a central planning agency. And there is something disreputable about using a term like “central planning,” with its overtones of totalitarian domination and suppression of individual rights, as a rhetorical bludgeon with which to beat up a person or an institution with whom you have a policy disagreement.

When I remarked that Dr. Judy Shelton had indulged in this of ideological overkill in her recent paean to the gold standard, one commenter, R. H. Murphy, was kind enough to provide a link to a forthcoming paper by Jeffrey Hummel comparing the views of Milton Friedman and Ben Bernanke on the causes of the Great Depression and the appropriate role for monetary policy in general and in countering a severe economic downturn in particular. I don’t know Hummel’s work that well, so I was pleasantly surprised with what I read. I learned a lot from the paper, even though, at a theoretical level, it seems to me that Hummel dismisses Bernanke’s concerns about the breakdown of financial intermediation in a depression without sufficiently considering the potential consequences of such a breakdown. And I would also observe in passing that the paper mistakenly takes Friedman’s view of the causes of the Great Depression as being somehow definitive, when, in fact, Friedman’s explanation misses almost entirely the nature of the monetary disturbance that caused the Great Depression, attaching far too much attention to the bank failures that were just a symptom of a far larger monetary dysfunction rather than an independent cause of the monetary contraction.

But I bring up Hummel’s paper not to comment on Friedman’s explanation of the Great Depression, but because Hummel, in his concluding section, attempts to make the case that Bernanke has gone beyond the kind of central banking that Friedman considered appropriate. Defending the now much maligned Alan Greenspan, Hummel points out that Greenspan’s approach of flooding the market with liquidity during times of economic distress was not followed by Bernanke in 2008 when the economy was already in the early stages of a financial crisis and in a rapidly worsening recession. Instead, Bernanke was attempting to provide more sophisticated targeted assistance to the financial sectors experiencing acute distress while keeping the lid tight on overall monetary base. This is an extremely important observation and a damning criticism of Bernanke. But even if true, and I am pretty sure that it is, how does that make Bernanke a central planner? It may make him an interventionist, or even a dirigiste, but that does not make him a central planner.

If you go back to the classical discussions of central planning by Mises and Hayek, you will find that their key point about central planning was that the idea of a central plan is incoherent, because the informational requirements to formulate a central plan were beyond the capacity of an aspiring central planner to satisfy. In The Road to Serfdom Hayek extended the critique to explain why a serious attempt to implement central planning as an economic system would inevitably lead to a totalitarian political system. This position has been characterized over the years by Hayek’s critics (and, in their supreme cluelessness, by many of his self-styled supporters) as a claim that any intervention in the economy leads to totalitarianism, a mischaracterization that Hayek always resented and protested against. But those who call central banking a form of central planning are making exactly the same categorical error about the relationships between intervention, central planning, and totalitarianism to which Hayek took extreme personal offense.

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33 Responses to “Central Banking Is Not Central Planning”

I’m not sure I follow your argument. You seem to be saying that central banking isn’t a form of central planning because it is intervention. Doesn’t this rest on an assumption that intervention isn’t a form of central planning? Can’t it be both?

When you cite Mises and Hayek you say “their key point about central planning was that the idea of a central plan is incoherent, because the informational requirements to formulate a central plan were beyond the capacity of an aspiring central planner to satisfy”. Are you arguing that the informational requirements to conduct satisfactory monetary policy are within the capacity of central bankers? Because isn’t that the nub?

Finally, in short, do central bankers attempt to plan the economy? And are they a centralised organisation? Doesn’t that make them central planners??

Cooper and Dougherty don’t seem to be claiming that central banking is itself a form of central planning, but something more like Hummel’s claim that the Fed has shifted from mere central banking to more of a planning role.

Anthony, No I am not saying that central banking isn’t central planning because it’s intervention. I am saying that it’s not central planning because it is not a central authority that allocates resources across all possible uses. In general, no central bank has ever done that. A central bank decides how much of the asset under its sole and unique control to make available to the public, either by controlling the quantity of the asset or by setting a price at which it is prepared to provide to those entitled to obtain it from the central bank. The disposition of resources given the central bank’s decision about how much of the asset that it uniquely controls is to be made available is then left to the private and independent decisions of all private decision makers. How is any central planning occurring? Can you cite a single instance in which Hayek or even Mises ever equated a central bank with a central planning agency?

You asked: “Doesn’t this rest on an assumption that intervention isn’t a form of central planning? Can’t it be both?” Well, on reflection, I admit that semantically, you are within your rights to define intervention and central planning in such a way that the two are identical. But clearly, that is not how Hayek or Mises defined the terms. When Mises wrote his Critique of Intervensionism, the whole point of his argument was that one intervention would beget another and then another and so on until finally the government would, without having intended to do so, be in control of the entire economy. According to you, the whole book was unnecessary because intervention is identical to central planning. Too bad that you weren’t around then to tell Mises not to waste his time trying to prove what you have just established by definition. By the way, I don’t accept that Mises actually proved what he set out to, and neither did Hayek or Roepke, or most other liberal economists, but that is a whole other story.

You ask: “Are you arguing that the informational requirements to conduct satisfactory monetary policy are within the capacity of central bankers? Because isn’t that the nub?” You are implicitly identifying conducting
“satisfactory monetary policy” with “central planning.” A central bank may or may not lack the information it needs to discharge its responsibilities in a satisfactory manner. But it is not incoherent for a central bank to attempt to do so. It is incoherent to try to centrally plan the decisions of an untold number of separate consuming and producing agents.

You ask: “do central bankers attempt to plan the economy?” Again, you are being slippery with your semantics. Central bankers are not assigning production quotas to any factories; they are not telling businesses how much to invest; they are not controlling the employment decisions of any private business. In my terminology, then, the answer is a flat “no.” They are not attempting to plan the economy.

“According to you, the whole book was unnecessary because intervention is identical to central planning”

You’ve misinterpreted my argument here – I’m not saying that they’re the same thing. There are actions governments might take that we could call “intervention” but wouldn’t constitute central planning. I grant you that there’s a difference between influencing the demand or supply curve in order to manipulate the market price, and actually being involved in the direct allocation of resources. We can agree on this distinction – that a minimum wage law is not an example of central planning.

“Central bankers are not assigning production quotas to any factories, they are [do you mean *not*?] telling businesses how much to invest, they are not controlling the employment decisions of any private business”. We would both agree that they are *influencing* these decisions, but – as I understand it – your point is that they are not *controlling* them.

But is there any gray area between influencing and controlling? Isn’t the whole point of Jeff’s article to draw attention to the fact that central banks are increasingly becoming involved in the direct allocation of resources?

My concern is that you assuming that the only form of central planning is a comprehensive central plan – e.g. you say “a central authority allocating resources for all possible uses”, and “control of the entire economy”. It strikes me that if it’s a cop out to equate all forms of intervention as central planning, it’s similarly obfuscatory to say that central planning only occurs once that last step on the Road to Serfdom is taken.

To use central planning in the strict sense that Mises did is like using altruism in the strict way that Kant did. It renders the words useless to language. For Mises, even a truly socialist state wasn’t central planning because policy-makers could look out through the glass greenhouses of their cultivated gardens of economic schemes and legal frameworks, and into the wild market of the world. To Mises they were nothing more than companies, highly integrated both vertically and horizontally. The disasters and woes of central planning would only become fully evident once socialism had spread across the entire world, leaving no room for markets anywhere.

The question, then, is one of degree. That question can addressed easily by simply looking at the purpose of different types of institutions. A socialist government is designed to control the quality of investment, and a central bank is designed to control the quantity of investment. The plan of the socialist is grander, yet the plan of the banker is still grand indeed. And it is a plan that no doubt stems from a certain epicenter

Isn’t that really all central planning means when you undress it from its ideological overtones? In this sense, any legal framework is a central plan, and the only question is how grand the plan is in size and scope, and how fit the governing body and we as human beings are for executing the plan. The socialist calculation debate was won by those who said that controlling the quality of investment from one epicenter was incoherent; who knows who will win the central-banking-calculation debate? The greatest obstacle here is that we are surrounded by government issued paper and government institutions that control its supply at every direction. We are not too unlike the fish that asked “What is water?”

David, this strikes me as a semantic debate, not a substantive one. You define central planning (in your response to Anthony’s first comment) so narrowly — “a central authority that allocates resources across all possible uses” — as to define it out of existence. I’m not sure that even Gosplan qualifies under this definition. Of course, if by “central planning” you mean socialism, as in government ownership of all productive resources, then the mere existence of central banking isn’t socialism.

But I think you’re being too hard on those who use “central planning” in the colloquial sense of “a significant government role in controlling the production or use of certain commodities or industries.” I have no problem saying, for instance, that the USDA is involved in “central planning” in agricultural markets, though obviously it doesn’t attempt to control the entire industrial economy. If a writer criticizes Obamacare as “healthcare socialism,” I don’t retort that well, it’s not really socialism because the government would only be taking over the healthcare sector. Likewise, calling the belief that the a government agency should be responsible for setting interest rates a “central planner’s mentality” doesn’t seem outrageous to me.

Wonks, I actually did not read each of the contributions that I cited, I was just trying to show how pervasive this way of talking about central banking has become. I share the concerns of Hummel, and I suppose Cooper and Dougherty as well, but this is just another form of argument by sound bit and sloganeering, and I find it really annoying. Or couldn’t you tell?

Anthony, Sorry if I misinterpreted you. You are correct to say that when the central bank takes an action that changes the incentives of private decision makers and they respond to those incentives, I do not take that to be an instance of central planning.

You said: “But is there any gray area between influencing and controlling? Isn’t the whole point of Jeff’s article to draw attention to the fact that central banks are increasingly becoming involved in the direct allocation of resources?”

I agree that there is a gray area, but when Congress passes a law mandating that ethanol be blended into gasoline and subsidizes refiners for doing that, I haven’t heard anyone, even opponents, accuse Congress of engaging in central planning. And if anyone did, it would be obvious that it was an abuse of language. I am opposed to the sorts of measures Jeff describes, but does every measure undertaken by a government agency get called central planning? I mean, really.

You said: “My concern is that you assuming that the only form of central planning is a comprehensive central plan – e.g. you say “a central authority allocating resources for all possible uses”, and “control of the entire economy”. It strikes me that if it’s a cop out to equate all forms of intervention as central planning, it’s similarly obfuscatory to say that central planning only occurs once that last step on the Road to Serfdom is taken.”

Did I say the last step? Bernanke is steering too much capital towards the banking system. Shame on him. Does that come anywhere close to a comprehensive plan allocating resources to the entire economy? If you answer “yes,” I bet that you have your fingers crossed.

Peter, It absolutely is a semantic debate. And I say that there are people who are using central planning as a term of abuse to further their own political agenda even though the term central planning was never used in that way by the people who developed the definitive critique of central planning. You say that I define “central planning” out of existence. No thank God central planning collapsed in most of the countries that tried it and sooner or later will collapse in the few countries that still try to practice it. I am not arguing by definition. But we have plenty of historical experience of what happens under central planning and that experience bears no similarity to what the Fed, even under the misguided Bernanke chairmanship, is doing. Yes and now that you mention I also have a problem with casually accusing the President of the United States of being a socialist or Marxist, and I think people who use loaded terms like that to advance their own agenda, even if I sympathize with the agenda, are being intellectually dishonest. And I deplore it.

I didn’t say this to imply that you’re claiming we are there, just that you’re claiming we would need to be there for it to constitute “central planning”. I’m suggesting that it’s fair to characterise some forms of government activity as central planning before we get to that point. And – to really go back to the original argument – when there is a centralised committee that is meeting to make decisions that have such a large *influence* (albeit not *control* on the economy), then it’s a valid use of the concept.

I think our positions are fairly close, we’re just exploring how big that gray area is, how far along it we are, and how far along we’d need to be.

I’m not trying to say that you’re “wrong” or anything like that, just wanted to add some thoughts. Thanks for taking the time to respond.

So, if one were to say, “The Federal Reserve tries to centrally plan the monetary system,” or “Obama wishes to socialize the healthcare industry,” would that be OK? Or would that also be intellectually dishonest?

This really does seem like wordplay! Of course I’m sure we all agree that a market-based economy with a central bank is qualitatively different from a fully Sovietized economy. I would call the former “interventionist” and the latter “socialist.” But I don’t see any dishonesty in calling highly interventionist state A “more socialist” or “socialist-leaning” than less interventionist state B, even if neither features a comprehensive central plan. Surely none of the writers you cite above claim there is no difference between the US and, say, Cuba or North Korea.

Yes, I absolutely agree, central banking is not central planning: it does not attempt to allocate resources in the way central planning does and which is liable to Hayek and von Mises “economic calculation” critique. (A critique clearly vindicated,; particularly from nuggets of information such as Soviet planners using American mail order catalogues for setting relative prices.)

But it is a form of central control, and so is perhaps still liable to a more limited form of critique based on dubious incentives and limited information. As i noted here, if central bankers have a persistent tendency to be too sanguine about inflation much of the time, but disastrously over-concerned with it on some searing occasions, this surely raises the issue of the value of central banking in the first place. “But they just have the wrong theory” is always a suspect move in trying to explain away problems of central control. The pattern looks more like the perennial problems for central control of dubious incentives and information limitations.

John, You are right that Mises did try to distinguish between central planning for a single country and central planning for the entire world. I think that he made that distinction to avoid refutation of his prediction that central planning would break down. He did so by saying well if the Soviet state continues to function it is only because they are able to use market prices as benchmarks against which to compare their own shadow prices. That is different from saying that the Soviet Union was not a centrally planned economy in a sense that is completely different from saying that Federal Reserve System is a central planning agency. But my point is not to try to draw a precise line demarcating the degree of control over an economy required to qualify as central planning. No one in his right mind thinks that the US economy today is centrally planned. In my opinion, people who accuse the Fed of engaging in central planning do so because they think that by equating what the Fed does with central planning they can the Fed seem illegitimate. I on the other hand believe it is the rhetorical device that is illegitimate.

Anthony, unless you are prepared to say that the US economy is now centrally planned — and if you do believe that please tell me at what point in its history the US economy became centrally planned — I don’t see how you can say that any agency of the US government is engaged in central planning. If you are not willing to characterize the US economy as centrally planned, I don’t see how you legitimately can charge that any agency of the US government is engaged in central planning. And please forgive me if I replied to your earlier comment a bit sharply.

Peter, Yes in my view it would be dishonest or at least an abuse of language. A government monopoly may be a bad thing, although plenty of liberal economists have supported government monopolies when they thought that the alternative was a private monopoly. Obama, as I understand it, wants to add to the level of government control over the health care industry which is already subject to a very high degree of government control. So it’s not clear to me why the system that we had before Obama was somehow free enterprise and what Obama is giving us is now socialism. Again, I don’t understand what centrally plan the monetary system means. The Fed does have a legal monopoly over certain aspects of the monetary system, so how does central planning of the monetary system differ from a simple acknowledgment that the Fed is the monopoly supplier of currency and certain other services? As I said before, my claim is that by using the term central planning to describe what the Fed is doing, Fed critics are dishonestly trying to suggest that the Fed is engaging in the sort of illegitimate and indefensible activity that we associate with North Korea and Cuba. This is argument by sound-bite which I find really annoying.

I’ve travelled enough to know that the US is not a “centrally planned” economy, but I reject (as I believe Mises and Hayek did) the notion that a centrally planned economy and a market economy are mutually exclusive. The USSR was essentially a market economy riddled with rent seeking with large scale intervention. I don’t think there’s a point at which we can empirically determine when we cross from A to B, since as Mises taught us a centrally planned economy is incoherent. I think it’s perfectly legitimate to say that these are really ideal types, the whole purpose of which are to be able to determine which direction we might be moving. When the UK government nationalized the health service, and to this day my health care is allocated based on a rationing system adopted by politician – I think we can say that this is a form of central planning. Central banks are less so, but we’re talking gradations now.

Lorenzo, I have no objection to your formulation. On the other hand, although I wrote a book about free banking and suggested what I thought was a system with optimal properties, I have become disillusioned enough over the years to be skeptical about whether any system that we can think of will be able to deal with every possible contingency. Any institution that we set up, I am afraid, will have some aspect of second bestness to it. So the fact that we can identify problems with central banking in the real world does not automatically prove that, all things considered, a moderate degree of risk aversion may make it rational not to do to much tinkering with the system that we have now rather than try to invent an entirely new system to replace it. We can’t really do a beta test on a new monetary system.

Anthony, Where did Mises and Hayek reject the idea that a market system and central planning are mutually exclusive? I actually think that the national health service is a good example. The British government has pretty much taken over the direct provision of all health services to the British population. I think that the NHS violates liberal principles, and I would be very upset if the US were to adopt such a system. But I don’t regard it as central planning, because the price system continues to guide the allocation of resources in general in Britain and even the NHS continues to operate in the context of a market system that controls the allocation of resources for the rest of society. But the provision of health care has, for good or ill, been carved out as a special case in which markets are not operating for the provision of services to end users, while they are operating for the purchase of the inputs used by the NHS. Again, this strikes me as bad policy, but hardly an example of central planning as understood by Mises and Hayek. This is off topic, but can you explain to me why support for NHS in Britain is so strong that no politician since it was enacted, including Mrs. Thatcher and the even more doctrinaire Enoch Powell, so much as uttered a peep about changing the basic principles under which NHS operates?

Hi David
I’m happy to summarise our views that I think the NHS is a form of central planning, and it’s existence moves the UK economy closer to being a centrally planned one. I understand your point – that it doesn’t mean that the UK economy is centrally planned, that calling the NHS centrally planned isn’t quite how Mises and Hayek used the term, and compared to real world instances of central planning it is somewhat churlish to use such language – but we can leave it at that.

“Where did Mises and Hayek reject the idea that a market system and central planning are mutually exclusive? ”

We might be at crossed wires here (so easy on the internet…) but my basic point is that they showed how socialism was impossible. Thus any attempt to deliver it was doomed to failure – not in the sense that you couldn’t have a socialist state, but that it wouldn’t be socialism proper. In order for people to be fed it would be forced to accept forms of monetary calculation. When Mises says (in Economic Calculation in the Socialist Commenwealth), “every step that takes us away from private ownership of the means of production and frm the use of money also takes us away from rational economics” I think he provides a warning of the encroachment of central planning versus decentalised planning regardless of how you label the system. Indeed I read the “socialist calculation ebate” to be as much a criticism of “third ways” as of the socialisation of the means of production. Pete Boettke’s book, “Why Perestroika Failed”, is the best example of viewing it as a continuum rather than two alternatives. When I learnt econ we learnt about “centrally planned” and “market” economies, and the strengths and weaknesses in both. We then were taught about “social democracy” as a third way incorporating the best of both. It was Mises and Hayek who taught me that these aren’t distinct categories – these is a continuum between rational economic calculation and “steps in the dark”, and all economies are somewhere along it, different in scale not scope.

Regarding the NHS – it’s a fantastic question and I wish I knew the answer. I’m loathe to offer quasi-religious reasons but there is definitely a sort of national reverance for the institution, forcing only the most cavalier politicians or commentators to even dare suggest it needs to be altered. The key issue is that it’s free at the point of use, and people associate that with being “free”. If people were aware of the true cost (i.e. if they actually wrote a check each year to the tax man, and could ssee what proportion of that was funding the NHS), it might get people thinking. If people realised that voucher programmes can mean that health service can be available to the less well off despite not being *provided* by the state, then that would help. Something of interest is that we do have private healthcare provision, and this isn’t the preserve of the rich. It’s common for people on middle incomes to have private health insurance, and it’s common for all people to “go private” if the waiting lists for what they require are sufficiently long. This is interesting, because it demonstrates that people don’t have a strong passion for the use of the NHS. If they can get treatment quicker by going private, people seem to have no qualms about doing so. It seems that even those who don’t use the NHS, and pay twice to go private, are still supportive of it. The fact that it is such a holy cow means that there’s little chance of having genuine cuts in spending (because so much of spending is healthcare), and sadly the worse the NHS performs the greater the argument that it needs more funding! Very depressing.

Anthony, Thanks for your thoughtful comments. I don’t think that there is much more left for me to say. But I enjoyed this opportunity to exchange ideas with you and I hope that you will keep reading and commenting from time to time.

Having now read Hummel’s paper, it struck me that the system he describes Bernanke as having created is eerily similar to that the Japanese regulatory authorities ran over financial markets in the decades prior to the collapse of their “bubble economy”. Not in the details of the mechanisms used, but in the overall “managing” of credit and financial intermediation. If I am correct, it makes Bernanke’s policy replication of Japan even more complete and, in a way, even more bizarre.

If the Fed doesn’t centrally plan, what on earth are the board of governors and, more importantly, the FOMC for?

Whether they do or don’t centrally plan, they certainly try to, as their goal is to centrally maneuver the entire economy in a direction they see fitting. If your read the areas the Fed covers in their policy decisions, there is little to nothing they aren’t trying to effect.

Mises point on central planning anyways is that prices arise from voluntary exchanges, not an arbitrary bureaucracy. The central bank centrally decides interest rates, a price they cannot know and enforce the market exchange for. Therefore the central bank will miss the appropriate price and either exceed it or fall short, leading to unnecessary contractions immediately or artificial booms. The only reason people say the Fed is a central planner is to hit home this point, and since this point remains true, I’m not sure what your point is.

Adam, You asked: “If the Fed doesn’t centrally plan, what on earth are the board of governors and, more importantly, the FOMC for?”

Um, to set monetary policy?

You said: “Whether they do or don’t centrally plan, they certainly try to, as their goal is to centrally maneuver the entire economy in a direction they see fitting.” Sorry to be so blunt, but I am astonished that you can’t see the distinction between setting a policy variable (Bank Rate) at a certain level with the intention of achieving certain goals for the economy (growth rates for output, employment, and prices) and planning the output and employment levels for each sector or industry in the economy and actively enforcing those plans through detailed manipulation of individual prices or through direct commands. Hayek and Mises were perfectly aware of monetary policy and its effects on economic activity and prices, and they had some pretty scathing remarks (some of which I agree with and many of which I don’t) to make about monetary policy both in theory and in practice, I defy you to produce for me a single instance in which either of them ever characterized monetary policy as central planning. So who is more orthodox in his use of the term central planning here, you or I?

“If your read the areas the Fed covers in their policy decisions, there is little to nothing they aren’t trying to effect.” Yes, we all agree that monetary policy has very wide-ranging effects. So does the tax rate. Is setting the tax rate a form of central planning? Not unless, the tax code was infinitely more complex than it is now and if it was constantly subject to change by a an individual or board in order to induce individual agents to change their production and consumption decisions to conform to the central plan. We are talking about entirely different types of effects here.

You said: “Mises point on central planning anyways is that prices arise from voluntary exchanges, not an arbitrary bureaucracy. The central bank centrally decides interest rates, a price they cannot know and enforce the market exchange for.” Again, i am sorry to be so blunt, but this is totally wrong. The rate that the central bank conventionally sets is a rate for overnight (or perhaps extremely short-term) loans. It does not set and has no power to set any other interest rate except insofar as it affects the expectations of traders about the future. The markets through the individual decisions of traders based on their expectations of the future including future central bank policy, determines interest rates.

“Therefore the central bank will miss the appropriate price and either exceed it or fall short, leading to unnecessary contractions immediately or artificial booms.” This does not follow from any premise that you have established. It is merely an assertion that you have adopted from your reading (I am assuming) of some version or another of Austrian business cycle theory. But even if true, the chief exponents of Austrian business cycle theory, Mises and Hayek, never identified central banking and central planning, so your quarrel is as much with them as with me.

“The only reason people say the Fed is a central planner is to hit home this point, and since this point remains true, I’m not sure what your point is.” Well I am not sure which point it is that you think remains true, but in any case, I hope that this has helped you to see what my point is.

“This does not follow from any premise that you have established. It is merely an assertion that you have adopted from your reading (I am assuming) of some version or another of Austrian business cycle theory. But even if true, the chief exponents of Austrian business cycle theory, Mises and Hayek, never identified central banking and central planning, so your quarrel is as much with them as with me.”

Its not an assertion. Its a basic economics principle dealing with price controls. If a price is lower than the equilibrium supply and demand you will have shortages in supply. If a price exceeds you have shortages in demand.

Applied to the interest rate a lower interest rate than the Wickesellian natural rate sets you outside the production possibility frontier but a higher interest rate puts you inside.

All that matters is whether or not Mises’ argument against economic calculation in the socialist commonwealth applies to the Fed’s attempt at controlling prices. The answer is unequivocally yes.

The difference between the market controlling interest rates versus the Fed is central planning of certain prices, very important ones for that matter, and the extreme influence of resource allocation economy wide.

You said: “Its not an assertion. Its a basic economics principle dealing with price controls. If a price is lower than the equilibrium supply and demand you will have shortages in supply. If a price exceeds you have shortages in demand.” You are referring to your earlier statement that the central bank would not set its interest rate appropriately and as a result “leading to unnecessary contractions immediately or artificial booms.” I fail to see any connection between this assertion and the theory of price controls. No central bank engages in price controls, they offer to lend at a particular interest rate, and market participants may choose either to accept or reject that offer. Or in the case of the Fed setting the Federal Funds rate, the Fed announces a target and engages in open market operations sufficient to ensure that the target is met. There is no shortage or surplus of funds as there is in markets in which a price control is imposed. Everyone who wants to trade at rate set by the central bank is able to do so. Any further implications you draw from the policy are based not on the economics of price controls but on your understanding of the Austrian theory of business cycles which, despite Mises’s claims or those of his most extreme followers (but only his most extreme followers, not Hayek for example), is not on the same level of a priori certainty as, say, Euclidean geometry.

You said: “Applied to the interest rate a lower interest rate than the Wickesellian natural rate sets you outside the production possibility frontier but a higher interest rate puts you inside.” Again this is an empirical assertion about the effects of central bank policy. It may or may not be true depending on a whole range of factors, like the expectations of market participants about how long the central bank will maintain its interest rate at the current level. Austrian theory typically assumes that central bank policy raises or lowers the entire yield curve up or down without considering that it may only affect the short end of the curve.

You said: “All that matters is whether or not Mises’ argument against economic calculation in the socialist commonwealth applies to the Fed’s attempt at controlling prices. The answer is unequivocally yes.” Sorry to be blunt, but the answer is unequivocally no. Mises’s argument was that without a functioning price system, it was incoherent even to try to evaluate whether a given resource would be better applied to one of two alternative uses, let only the myriad of alternative uses in which a given resource may be able to function. For a central bank, there is already a functioning price system, so it is not incoherent to ask whether an increase or a decrease in its interest rate would lead to, on balance, an improvement or a worsening of economic performance. Even if we accept, Austrian business cycle theory, the implication is not that what the central bank does is incoherent, just that it is ignoring certain long-run effects that it would be wise to take into account. Nothing incoherent is happening.

You said: “The difference between the market controlling interest rates versus the Fed is central planning of certain prices, very important ones for that matter, and the extreme influence of resource allocation economy wide.” Again, you are not really getting what the argument against central planning was all about. A price within a functioning market economy may or may not be set at the appropriate level. If it is not, certain misallocations of resources result. Austrian business cycle theory has a theory of what the consequences are if the interest rate at which banks lend is, in some sense, too low. There is no direct logical connection between the theory of the consequences of an inappropriately set lending rate by the banking system and the theory of central planning without a price system is incoherent or why any attempt to determine in detail the allocation of resources will be unable to executed.

Oh, and by the way, in its original formulation by Mises and by Hayek, both of whom, as you noted, adopted, with certain modifications, the Wicksellian notion of a natural rate of interest, it is the private banking system that fails to set the lending rate at the natural rate. The Wicksellian natural rate is unobservable and there is no market mechanism for discovering it. All Mises ever said was that central banks had a bias toward low interest rates because of political reasons so that central banks made the problem worse. Hayek on the other hand, though that it would be theoretically possible for a central bank to follow a policy of stabilizing money income, i.e., NGDP, and that by doing so central banks might actually be able to mitigate the business cycle.

I’d like to keep up the discussion, as you have a unique perspective, which i still disagree with, but am interested to hear more about.

Anyways, you say:

” I fail to see any connection between this assertion and the theory of price controls. No central bank engages in price controls, they offer to lend at a particular interest rate, and market participants may choose either to accept or reject that offer. Or in the case of the Fed setting the Federal Funds rate, the Fed announces a target and engages in open market operations sufficient to ensure that the target is met. There is no shortage or surplus of funds as there is in markets in which a price control is imposed. Everyone who wants to trade at rate set by the central bank is able to do so.”

Market participants may choose relative losses over working within the Fed’s target range. That’s about as much of a choice as saying that in a price controlled environment you can abide by the legal price setting or go to jail.

Since the Fed now works by setting interest on reserves, they certainly control incentives. There is no shortage or surplus of funds, I agree since the price just changes, though the Fed disagrees, which is why they contract or expand money (supposedly to quell money shortages or deal with too much liquidity). The surplus and shortages develop in resources, hence my invoking of the production possibility frontier.

You say:

“Again this is an empirical assertion about the effects of central bank policy. It may or may not be true depending on a whole range of factors, like the expectations of market participants about how long the central bank will maintain its interest rate at the current level. Austrian theory typically assumes that central bank policy raises or lowers the entire yield curve up or down without considering that it may only affect the short end of the curve.”

The point you’re missing is the Fed changes the supply of loanble funds, so certainly affects rates across the curve as this is a variable in determining all rates. The short rate is always a sub-component of the long rate so any effect on the short rate will impact the long rate. Even if they contract money later, they are just affecting rates across the curve again.

Furthermore, without rules, there is no full discounting as uncertain elements will always remain. Even if it seems to balance in the end, its not to say they had no effect. Furthermore the Fed ensuring a given distortive rate, even for a short period, has real effects which will last into the future.

Also discounting cannot be fully done because the Fed affects the distribution of funds. Money is printed unevenly in space and time, and this wealth transfer affects everything. Even if the money is discounted, it means wealth will be in the hands of different people with different time preferences which affects the interest rate.

You say:

“Mises’s argument was that without a functioning price system, it was incoherent even to try to evaluate whether a given resource would be better applied to one of two alternative uses, let only the myriad of alternative uses in which a given resource may be able to function. For a central bank, there is already a functioning price system, so it is not incoherent to ask whether an increase or a decrease in its interest rate would lead to, on balance, an improvement or a worsening of economic performance. Even if we accept, Austrian business cycle theory, the implication is not that what the central bank does is incoherent, just that it is ignoring certain long-run effects that it would be wise to take into account. Nothing incoherent is happening.”

The central bank is constantly distorting the natural interest rate and leading to wealth transfers. The more active the central bank, the more distortive they are. If the central bank does anything, they are pushing the interest rate away from where it would otherwise be. If capital becomes scarce, the interest rate should rise, but the Fed uses this scenario to add money to confuse the market as to the true level of capital.

A Fed that is constantly expanding their a balance sheet is pushing down interest rates, discouraging savings and encouraging consumption. They are also confusing the signals that are required to allocate resources in a sustainable, rational manner, which is why the Fed is at the heart of the boom bust and Mises’ argument still applies.

“The Wicksellian natural rate is unobservable and there is no market mechanism for discovering it.”

This is fine, but the market more efficiently targets this rate in an unfettered state. The distortions by the Fed we can know distort the natural rate, without needing to know the natural rate. There action hampers the markets ability to efficiently discover the rate. And by nature of the Fed expanding their balance sheet, we know they are distorting the rate to the low side, we just can’t quantify the magnitude by which they are doing so. However, we do know that they more they do the more they distort.

*I apologize for coming off over simplistically, but I’m writing in a bit of a rush. No time to edit either😦 Hopefully I can better explain myself as the discussion progresses.

Adam, You said: “Market participants may choose relative losses over working within the Fed’s target range. That’s about as much of a choice as saying that in a price controlled environment you can abide by the legal price setting or go to jail.” I am sorry, but I don’t see the analogy at all. Is a legal monopolist engaging in price control? Would you care to provide me with a cite from Mises to support that? Just to be clear, I don’t regard anything that Mises says as authoritative, but I think that you are making statements that not even Mises would agree with.

You said: “Since the Fed now works by setting interest on reserves, they certainly control incentives. There is no shortage or surplus of funds, I agree since the price just changes, though the Fed disagrees, which is why they contract or expand money (supposedly to quell money shortages or deal with too much liquidity). The surplus and shortages develop in resources, hence my invoking of the production possibility frontier.” Again I am just not following what you are saying here.

You said: “The point you’re missing is the Fed changes the supply of loanble funds, so [that?] certainly affects rates across the curve as this is a variable in determining all rates. The short rate is always a sub-component of the long rate so any effect on the short rate will impact the long rate. Even if they contract money later, they are just affecting rates across the curve again.” The short rate affects the long rate, but only slightly unless the short rate is expected to persist in the long run. Austrian theory to my knowledge glosses over that distinction entirely.

You said: “Also discounting cannot be fully done because the Fed affects the distribution of funds. Money is printed unevenly in space and time, and this wealth transfer affects everything. Even if the money is discounted, it means wealth will be in the hands of different people with different time preferences which affects the interest rate.”

If all you are saying is that the Fed’s actions have effect that favor some people over others, that may very well be true, but my demand for anything favors those people whose products I demand relative to those whose products I don’t. That argument seems to me entirely irrelevant.

You said: “The central bank is constantly distorting the natural interest rate and leading to wealth transfers. The more active the central bank, the more distortive they are. If the central bank does anything, they are pushing the interest rate away from where it would otherwise be. If capital becomes scarce, the interest rate should rise, but the Fed uses this scenario to add money to confuse the market as to the true level of capital.”

Again, all you are doing is asserting. The natural rate in unobservable, and there is no market mechanism that ensures that the market rate coincides with the natural rate, so as a matter of economic logic, you have no basis to say that the central bank is more likely to move the market rate away from rather than closer to the natural rate. At best you may be making some sort of historical generalization about what central banks have done historically, but you are making these assertions as if they followed logically from some indisputable axioms of human conduct.

You said: “A Fed that is constantly expanding their a balance sheet is pushing down interest rates, discouraging savings and encouraging consumption. They are also confusing the signals that are required to allocate resources in a sustainable, rational manner, which is why the Fed is at the heart of the boom bust and Mises’ argument still applies.” That might be true if you could establish some way for determining where the market rate was in relation to the natural rate, but you can’t.

You said (about the unobservable nature of the natural rate): “This is fine, but the market more efficiently targets this rate in an unfettered state.” Again you are relying on assertion, not logic.

“The distortions by the Fed we can know distort the natural rate, without needing to know the natural rate.” More assertion.

“And by nature of the Fed expanding their balance sheet, we know they are distorting the rate to the low side, we just can’t quantify the magnitude by which they are doing so.” If the Fed expands its balance sheet to counteract hoarding that would cause a contraction in money income, then expansion of the balance sheet does not cause a departure from the natural rate if we suppose that we are starting from a position of equality between the market and natural rates. Hayek explicitly acknowledged the truth of this proposition.

“However, we do know that the more they do the more they distort.” Assertion once again.

You said: “I apologize for coming off over simplistically, but I’m writing in a bit of a rush. No time to edit either😦 Hopefully I can better explain myself as the discussion progresses.”

No need for apologies. However, I am getting a little worn out trying to teach you the Austrian theory of business cycles. The point of this post was not to get into such a discussion. Even if I accepted your characterization of what Austrian business cycle theory says or accepted the truth of all its unproved assertions, it would still not mean that central banking as understood by Mises and Hayek had anything to do with central planning as understood by Mises and Hayek. So I claim that any characterization of central banking as a form of central planning is an illegitimate and tendentious distortion of the concept of central planning as understood by Mises and Hayek.

If the government has a monopoly on something, then the quantity supplied and methods of production are decided by some “central plan” for that particular thing. The Fed, FDIC, and US Mint are immune from ordinary market pressures of profit, loss, and competition. They cannot use ordinary market feedback to calibrate their behaviour, but instead must use crude rules of thumb and technocratic statistics gathering. The Fed has even recently taken to attempting to allocate credit among private institutions.

By your logic, the NHS in Britain is not and example of centrally planning healthcare. Maybe the words just do not mean what they used to mean: that happens all of the time.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.